Question

What is principle-agent problem? What is incentive system and how did that play a role in the Wells Fargo scandal of fake accounts?

Answer 1

The principal-agent problem arises

1. The principal does not have full information about agent behavior.

2. The output of the principal diverges does not match with the agent output that leads to the problems of moral hazard and conflict of interest.

example- a shareholder (principal) hires a manager (agent) to maximise profits for his firm. but the manager does not share the same interest according to the owner and the shareholder don't know that the manager is fulfilling the contract or the business is running an inefficient way or efficient way. Lack of this information leads to the principal-agent problem.

Incentive way

1. Superiority Wage or efficiency wage-  when workers marginal productivity is higher rather than a marginal wage, they will do less work or focus on their self-interest rather than that of the principal but if their wages rise as they demonstrate on the company interest. it helps to solve the principal-agent problem.

2. provide incentives on achieving the goal - this type of incentives encourage the worker to do hard work that leads to benefiting the company best interest.